As the Union Budget draws near, tax specialists from the banking and capital markets sector are advocating for more transparent regulations and an updated framework concerning tax deductions on head office (HO) expenses incurred by foreign banks operating in India through branch structures. This call for clarity aims to streamline processes and reduce litigation in the financial landscape.
Current Framework and Challenges
Vijay Mani, Partner and Banking & Capital Markets Leader at Deloitte India, along with Russell Gaitonde, Partner, have outlined their expectations and recommendations on this pressing issue. They explain that foreign banks' head offices provide essential shared management services to their Indian branches, including business strategy guidelines, accounting, human resources, payroll, IT support, and legal assistance. For some institutions, these services are delivered through regional hubs located in Singapore or Hong Kong, with common expenses allocated among group entities using appropriate allocation keys.
Indian tax law, specifically Section 44C of the Income Tax Act, already permits non-resident taxpayers, such as foreign banks operating via branch offices, to claim deductions for HO expenses when computing business income. However, this deduction is limited to the lower of either the actual expenditure incurred or 5 percent of the Adjusted Total Income (ATI) of the taxpayer.
Practical Hurdles and Documentation Issues
The experts highlight that branch offices often rely heavily on their global headquarters, especially during the initial years of establishing operations in India and in subsequent phases for implementing strategies and operational adaptabilities developed by the HO. Despite the existing provisions, practical challenges arise in documentation and assessments.
The burden of proof for correctly claiming HO expenditure rests on the non-resident taxpayer, who typically procures a certificate from an overseas Chartered Accountant (CA) to confirm the nature and quantum of such expenses. However, the Central Board of Direct Taxes (CBDT) has not issued any specific guidance on the documentary evidence required for claiming these deductions under Section 44C.
This lack of standardization leads to inconsistent practices among non-resident taxpayers regarding documentary evidence and the formats of overseas CA certificates. Consequently, these documents are sometimes challenged by Indian Revenue authorities (IRA), resulting in disputes and increased litigation.
Recommendations for Clarity and Reform
To mitigate these issues, the tax professionals urge the government to introduce clearer rules. They emphasize the importance of the CBDT issuing explicit guidance on the documentary evidence that non-resident taxpayers should maintain for claiming HO expense deductions, as well as prescribing a standardized format for the required certificates. This step is crucial for reducing tax litigation and providing certainty in the regulatory environment.
Specific Measures Proposed
Among the key recommendations is the introduction of a rule in the Income Tax Rules, 1962, that would mandate the acceptance of certificates issued by the overseas statutory auditor of a non-resident taxpayer as conclusive evidence for claiming deductions under Section 44C. Additionally, the CBDT should prescribe a specific format for these certificates to ensure uniformity and reliability.
Furthermore, the experts propose expanding the scope of eligible expenses to align with contemporary business models. They suggest that the CBDT issue a clarification to broaden the illustrative list of expenses considered as 'HO expenditure' under Section 44C. Consulting with industry stakeholders before finalizing this list would provide insights into new-age expenses, such as technology-related costs, that should be included.
Revising the Deduction Cap
The existing cap of 5 percent of ATI, established in 1976 when Section 44C was first introduced, is deemed outdated after nearly five decades. The experts recommend re-examining this limit to reflect modern expenditure patterns. Specifically, they advocate increasing the overall cap from 5 percent to 10 percent of ATI, which would better accommodate the financial realities of today's integrated and technology-driven banking operations.
Budget as an Opportunity for Reform
With cross-border banking becoming increasingly interconnected and reliant on advanced technologies, the upcoming Union Budget presents a pivotal opportunity to address these concerns. By implementing clearer rules and updated frameworks, the government can reduce disputes, enhance transparency, and provide long-awaited clarity on HO expense deductions, thereby fostering a more conducive environment for foreign banks operating in India.
